It’s tempting to want to intervene directly in markets to reverse this trend. One way to do so is to legislate some sort of pay cap — a maximum wage, if you will. I don’t think this is the right way to go. If the value-added by particular individuals — a CEO, financial innovator, top athlete, movie star, or what have you — is sufficient to merit pay above the cap, firms will figure out ways to get around it, for instance by providing non-monetary perks or deferring pay.

Stricter regulation of the financial sector is another possibility. This is a good idea, though mainly to prevent a repeat of the current economic downturn. If doing so has the indirect effect of reducing enormous payouts to financial players, so much the better.

The simplest and best strategy is to let markets largely determine high-end earnings and incomes and use the tax system to redistribute (more here and here). We should increase the top income tax rate and/or add one or more new rates for those with very high incomes.

This would help to reduce income inequality. And it follows logically from the rationale for progressive taxation: the higher your income, the larger the share of it you can afford to pay in taxes. Since high-end pretax incomes have risen sharply in recent decades, those at the top can afford to pay a greater share of those incomes in taxes than they did in the past. So far they haven’t had to do so, as the following data on the top 0.01% of households (about 10,000 households) indicate. This group’s average inflation-adjusted pretax income soared from $7 million in 1979 to $35 million in 2005, but the share of that income they paid in taxes didn’t increase.

What’s the proper effective tax rate on top incomes? It’s the rate that is consistent with fairness norms and produces the most tax revenue without (significantly) reducing work, investment, and innovation. I don’t know what that rate is. Maybe it’s 40%. Perhaps it’s 50% or 60%. It could conceivably be even higher. Figuring this out requires policy adjustment and monitoring.

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6 thoughts on “Reducing inequality: what to do about the top 1%”

how much money do you think will be recovered by that tax? do you have an estimate? I imagine the income of the top 1% has gone down a lot over the last year and a half, as it did after the stock market crash in 2000.

I love how middle class (nothing wrong with that) economists always opine about how the incomes of the top 1% should be taxed more.

Considering how hard people work to get into the top 1%, the poor measurement of lifetime earnings (i.e. earnings variability), the progressivity of the tax code and the fact that most services are means tested, why don’t you guys just leave it alone. When you actually add everything up a lot of these guys get a terrible deal. They make 2x as much as many other but work twice as much. When you adjust for taxes, the amount they pay for services & college tuition, things that are more expensive when you are busy (child care, laundry etc.), they end up with a much poorer quality of life than the average person. These people are basically suckers (to have sunk so much time & money into education, training and work) and there is no reason to give them an even more raw deal.

It’s great that we are discussing the subject, but as demonstrated by the recent example of the Federal government asking the US financial sector if they would be willing to offer some kind of transparency in exchange for $2 trillion of our tax dollars, and the financial community replying, “No, but thanks for the money,” “wealth and power” have shown that they essentially own the system, and that they are not going to concede any of their wealth or power, even under force of existing law.

So my best hope is that we might possibly get some kind of support under the poorest 1% and raise the baseline standard of living for everyone (wait, wait, don’t start laughing yet, let me finish), and maybe, just maybe, if most folks are freed from the distractions of scrambling after a subsistence living, the “underclass” might possibly, in a few generations, learn how to use the electoral process to support their interests instead of those of the top 1%.

I think a better way to encourage reasonable pay structures is to eliminate the right-off for excessive pay and compensation packages. A company can compensate in any manner they wish but the deduction for compensation cannot exceed say 10X the compensation of the lowest paid employee everything else comes out of profit.

While I think that taxes should be progressive I’m not convinced that the overall rates need to be increased (it’s possible they could be decreased) but fundamental changes should be made. First – income is income no matter how it is derived (salary, dividends, interest etc.) and is taxed at the same rate. Second, there should be a single standard deduction based on the modal cost of living (mcol) for where you reside (these data are readily available and 20-30 categories could easily accommodate all towns/cities in the US). Thirdly, to encourage responsible population growth you can have no more than two (lifetime) dependent-deductions for period of up to 24 years (if full-time students). The tax brackets would then be based on percentage of mcol starting at 125% (then 125-150%, 150-200%, 200-300%, 300-400%, >500%). No deductions for mortgages, 2nd homes etc. etc. – the single (mcol) deduction only. People wouldn’t even have to file income tax forms – they’d get a statement and if there was nothing to dispute receive their refund or pay the additional amount. I would like to see a consumption tax added for larger homes (say in excess of 2500 sq. ft. – unless, of course they were off-grid).

Divorce health care from employment and institute single-payer system eliminating unnecessary middleman (insurance industry). Someone needs to have enough courage to state what should be obvious some things should not be for profit – education, health care and justice are three that come to mind immediately.

Social Security -kind of a trading caps (versus cap and trade). Remove the income cap (all is taxed) but place a cap (say 150 -200% mcol) for recipients. In other words, you can receive SSN payments up to the minimal bracket (125% mcol) but no one making 200% mcol or greater may collect. The overall percentage (deducted) could be reduced significantly.

I believe these changes would reflect an increase in revenue received (no loopholes – severe penalties for failure to report income (individuals, banks, investment firms, accountants etc.). Additionally tort reform could contribute to health care costs (as well as tax revenue) in that monies received in accident, product liability, malpractice etc. would go into the health care pot – individuals could receive no more than actual loss monies (expected lost income things of that nature).

We would also benefit by changing corporate taxation by redefining what an American corporation is (in terms of percent of assets- including personal that need be in the US – no offshore shelters), provide incentives for those corporations that put employees above stockholders and eliminate certain deductions – for example advertising – sponsorship of sports teams, celebrity endorsements etc. only mean advertising costs (actors on scale etc.). They can pay for Tiger Woods, ludicrous Super Bowl advertising but it will come off their bottom line and will not be deductible expenses.

Oh, and no corporate bailouts. The entire banking/financial system was not broken – those ‘too big to fail’ should have been allowed to fail precisely for that reason. To get lending/consumer money flowing funds could have been released (with oversight) to the many functioning banks/financial institutions/credit unions. Assets should have been frozen for failing corporations (AIG et al -and their CEOs), bankruptcy initiated etc.